The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Friday, February 10, 2012

Dylan Ratigan and Eliot Spitzer call for a solution like the Blueprint for Wall Street rescuing Main Street

In their Huffington Post column, Dylan Ratigan and Eliot Spitzer observe about the problem of too much debt in the financial system, that 'there is no political solution to a math problem'. They argue that what is needed is a solution that both cleans up the bank balance sheets and reduces debt levels to what borrowers can afford to pay.

Under the Blueprint, banks act as a safety valve between the excesses in the financial system and the real economy. They do this by recognizing all the losses on the excesses in the financial system today and rebuilding their book capital through future retained earnings and equity issuance.

To restore confidence in the financial system and to ensure that losses are not hidden, banks would be required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.

Market participants could use this disclosure to assess the risk of each bank and to exert market discipline on management so that in an effort to rebuild capital they do not gamble on redemption.

An investigation, and a multi-billion dollar settlement. That sounds like a lot, until you put it into perspective. Here are the numbers.

Roughly half of homeowners with mortgages are underwater, which means they owe more than they own, to the tune of $1 trillion or so. And housing values are still declining so far in this "recovery", throwing more homes underwater.

In terms of an investigation, the Savings and Loan crisis used roughly 1000 FBI investigators to uncover fraud -- this task force taking on a crisis forty times more severe will employ 10 FBI agents.

There's a reason this is so inadequate to the problem at hand. For the last three years, the policy has been to impose a political solution to a math problem. It hasn't worked. America simply has too much mortgage debt to pay back.

Serious economic thinkers across the spectrum, from Democrat Alan Blinder to Republican Martin Feldstein to New York Fed President William Dudley, believe that there is only one solution -- writing down the enormous creaking mound of debt.

This solution is currently off the table, because writing down these unsustainable debts could cost our fragile banks enormous sums of money and possibly lead to a restructuring of one or more of our major banks.

Under the Blueprint, it would cost our banks enormous sums of money.

However, as this blog has documented, it does not mean a) that our banks are fragile or b) that they need to be restructured.

In fact, banks are not fragile. As the Europeans have shown, banks are perfectly capable of operating for years while insolvent. They can do this because of a) deposit insurance and b) access to central bank funding to replace unsecured creditors.

In fact, banks do not necessarily need to be restructured. The question of restructuring is driven by where value is created in the bank's franchise.

Avoiding this clear policy choice has resulted in our economy falling into a Japan-style "zombie bank" torpor, with debts carried on the books at full value which everyone knows will not be paid back at par....

Actually, this is an understatement of the problem. Remember that global financial regulators continue to run stress tests. At the end of the stress tests, the global financial regulators effectively 'bless' the valuation of these loans -- the amount of capital banks are required to raise pales in comparison with the difference between 'market' value for the debts and the par value of the debts.

The proposals on the table to solve this problem aren't inspiring.

With the exception of the Blueprint for Wall Street rescuing Main Street.

The meager mortgage settlement deal cut via furious and dramatic negotiations is unlikely to be meaningful. This settlement is essentially a continuation of previous alphabet soup housing programs, because it would not force banks to fundamentally restructure the trillion dollar underwater mortgage problem. It will generate headlines, but it will fail to address the extent of the problem.

State attorneys generals have accepted the settlement for a variety of reasons, one of the most frustrating being that they are substantially under-resourced and this deal moves cash their war.

This is not how to make good policy. And the housing market will continue to suffer if our political leaders cannot acknowledge the depth of the problem.

Instead, we need some serious discussion ... about how to write down mortgage debt.

Some proposals would reduce principal, while giving the banks an equity appreciation stake in the home. Others would deal with the problematic accounting standards which allow banks to overvalue second mortgages, and imply that one or more large banks needs to be restructured by the government. These are worth considering.

We think it's important, regardless of how policy-makers reduce the debt, to force the banking system to appropriately value mortgage debt.

Under the Blueprint, the banking system is forced to appropriately value mortgage and other debt. Equally importantly, because of ultra transparency, market participants can exert discipline to be sure that the debt is appropriately valued.

Anything less would simply continue the deflation and uncertainty in the housing market.

Ultimately, we need to look at our banking and housing system and engage in a ruthless yet compassionate evaluation of whether it is working to solve our national needs. Serious thinkers in both parties recognize that it isn't, and that we should find a way to write down this mortgage debt. Only then will we head down a pathway to a healthier banking system, and begin generating the roughly thirty million jobs that will bring America back to full employment. It's time ...

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.